Financial instruments usually carry three main types of risk.

• Credit risk: the risk that a debtor will not pay
• Liquidity risk: the risk that the asset cannot be sold as a buyer cannot be found.
• Market risk: the risk that the price will fall due to a change in market conditions.

Gold is unique in that it does not carry a credit risk. Gold is no one's liability. There is no risk that a coupon or a redemption payment will not be made, as for a bond, or that a company will go out of business, as for an equity. And unlike a currency, the value of gold cannot be affected by the economic policies of the issuing country or undermined by inflation in that country. At the same time, 24-hour trading, a wide range of buyers - from the jewellery sector to financial institutions to manufacturers of industrial products - and the wide range of investment channels available, including coins and bars, jewellery, futures and options, exchange-traded funds, certificates and structured products, make liquidity risk very low. The gold market is deep and liquid, as demonstrated by the fact that gold can be traded at narrower spreads and more rapidly than many competing diversifiers or even mainstream investments.

Gold is of course subject to market risk, as is clear from the experience of the 1980s when the gold price declined sharply. But many of the downside risks associated with the gold price are very different to the risks associated with other assets, a factor which enhances gold's attractiveness as a portfolio diversifier. For example, should a central bank announce its intention to engage in substantial sales of gold, as happened prior to the Central Bank Gold Agreement in 1999, this would be unlikely to have an impact on equity returns but could reasonably be expected to affect the gold price in the short run. Similarly, the specific risks to which bonds and equities are exposed, including pressure on the health of the government and corporate sector during an economic downturn, are not shared by gold.

One measure of market risk is volatility, which measures the dispersion of returns for a given security or market index. The more volatile an asset, usually the riskier it is. The gold price is typically less volatile than other commodity prices. This is because of the depth and liquidity of the gold market, which are supported by the availability of large above-ground stocks of gold. Because gold is virtually indestructible, nearly all of the gold which has ever been mined still exists, much of it in near market form. This means that sudden excess demand for gold can usually be satisfied with relative ease. As a result, gold is generally slightly less volatile than heavily traded blue-chip stock market indices such as the FTSE 100 or the S&P 500. In addition, when gold becomes more volatile, this tends to be associated with a rallying price. The reverse is true of equities, where rising volatility is an indication of market stress. So price volatility for gold contains different information from high volatility in equity markets, where it generally signals a crash or certainly nervous markets.

ENLARGE

For a broader range of volatility statistics >>